Social Security Hole Overwhelms Taxes, Cuts

Now that health care is off the
front burner, it’s time to fix Social Security. Social
Security’s trustees say the system needs only “modest
changes.” In fact, the system is desperately broke.

The proof is buried deep in the trustees’ own 2012 report
in a complex table, numbered IV.B6. The system’s actuaries
prepare the report’s tables. But what the trustees make of them
is up to the trustees. Clearly this year, as in others, the
trustees ignored table IV.B6. How else could they have come up
with their blase statement that Congress should address Social
Security’s finances “in a timely way”?

Table IV.B6 is a long-run balance sheet for Social
Security. It shows that the system’s $88.9 trillion in
liabilities exceed its $68.4 trillion in assets by $20.5
trillion.

The liabilities are the present value of the system’s
projected benefit payments, whereas the assets are the system’s
$2.7 trillion trust fund plus $65.7 trillion in projected taxes,
also valued in the present.

The $20.5 trillion fiscal gap separating Social Security’s
liabilities and assets -- its unfunded liability -- is enormous;
it is 1.4 times U.S. gross domestic product and 34 times annual
Social Security taxes.

Because $20.5 trillion is equal to 31 percent of the
projected taxes, the system is 31 percent underfunded. To pay
all promised benefits would require immediately and permanently
raising Social Security’s 12.4 percent payroll tax (split evenly
between employer and employee) by 31 percent, or 3.9 percentage
points.

Election Year

American workers would be ill-disposed, particularly in an
election year, to say goodbye to the current temporary two-
percentage-point payroll-tax cut, let alone surrender 3.9 cents
more per dollar earned in exchange for no extra benefits.

What about cutting benefits? The $20.5 trillion is 23
percent of the present value of projected benefits. Hence,
“saving” Social Security this way requires reducing all
benefits immediately and permanently by almost one quarter -- a
non-starter for most of the system’s 55 million beneficiaries.

How about increasing the retirement age from 67 to 70 for
those now 50 and younger? This means waiting 20 years to start
cutting benefits for new retirees by only 20 percent. That’s far
too little too late. If we wait 20 years to act, we will need to
cut benefits by almost 50 percent to eliminate the system’s
funding gap.

So why did the trustees ignore the magnitude of the
problem? One answer is that this is an election year and the
trustees are political appointees. Another is that the trustees
assessed the system’s finances based on a different table,
IB.IV5, which reports a much smaller unfunded liability -- only
$8.6 trillion.

The $20.5 trillion measure is called the infinite-horizon
unfunded liability because it considers all future Social
Security benefit commitments and tax receipts. The $8.6 trillion
measure is called the 75-year unfunded liability because it
considers only the next 75 years.

The trustees may reckon that looking out 75 years is far
enough given the enormous uncertainties the future holds. That’s
a terrible mistake for three reasons.

First, today’s children will be retired in 75 years. How
can the trustees focus on what our kids will pay to today’s
adults and ignore the benefits our kids will be promised, but
won’t receive?

Second, looking out just 75 years is an invitation to
procrastinate. The 1983 Greenspan Commission was charged with
fixing Social Security for good. But it looked only 75 years
ahead, thus ignoring 29 huge cash-flow deficit years that are
now in the current 75-year projection window. This decision
helps explain why the system is now in worse financial shape
than it has ever been.

Economic Relativity

Third, and most important, economic theory tells us that
the time path of a government’s cash flows, but not their
infinite-horizon present value, is a matter of how the
government chooses to label its receipts and payments. Thus,
table IV.B5 measures our choice of words, whereas table IV.B6
measures the system’s true economic condition. Since there is
nothing sacrosanct about the government’s choice of words, table
IV.B5 needs to be taken for what it is -- meaningless.

We need to fix Social Security without sacrificing its key
objectives. If we are going to ask younger generations to take
most of the hit for this broken Ponzi scheme, let’s give them a
modern Social Security system that’s simple, transparent, fair,
efficient and financially sound.

I propose a plan that freezes the existing system, pays off
all accrued benefits as they come due, and has all workers
contribute 8 percent of their pay to a personal security
account.

Account contributions are split between spouses and legal
partners, and the government makes matching contributions on
behalf of the poor, disabled and unemployed. All account
balances are collectively invested by a government computer in a
single, market-weighted, global index fund of stocks, bonds and
real estate. Wall Street plays no role and earns no fees.

Between ages 60 and 70, the same computer gradually
converts each person’s account balance into inflation-protected
annuities. In so doing, the government tops up each
participant’s account balance to ensure it at least equals the
beneficiaries’ contributions adjusted for inflation.

In paying off the system’s accrued, rather than its
projected, benefits, the system’s $20.5 trillion unfunded
liability is more than eliminated. Yes, this payoff to young
workers from the old system will be substantially less than they
have been falsely promised. But they will get a first-rate,
modern retirement system that will never go broke.

(Laurence Kotlikoff is an economist at Boston University
and the co-author, with Scott Burns, of “The Clash of
Generations.” The opinions expressed are his own.)